Greening the Conventional GDP

We now turn back to the concept of GDP. Its simplest definition denotes the value of all newly produced goods and services. It was contemplated by economists for centuries, but the idea was not formalized until the 1930s. Its purpose was to quantify the global demand in an economy so that business cycles could be better controlled. It performed in this role so well that both economists and lay citizens started to accept it as an overall indicator of economic activity and welfare, despite the fact that this was not its original purpose.

Abusing GDP and pretending it indicates what it could not triggers criticism from an environmental point of view also. Critics say, "GDP counts what does not count, and it does not count what counts," suggesting that it is not an adequate measure of welfare. For instance, if there is an oil spill, GDP may increase as a result of rescue and recovery actions. What is most disturbing is that GDP does not depend on the state of the environment. This state can either improve or deteriorate without any impact on the GDP. Even worse, the production of some goods (e.g., soundproof windows) may grow, increasing the GDP, while welfare (because of the higher noise outdoors) goes down. A similar effect can be observed when GDP grows in response to the increasing production of pesticides applied to counteract the declining resilience of ecosystems.

The difference between gross and net product is also important. Theoretically, the distinction is easy. Gross product contains all newly produced goods, including those that will substitute for depreciated and scrapped capital. However, the eliminated capital reduces the wealth of society. Therefore, from a welfare point of view, depreciated capital should be subtracted from the newly produced investment goods. The result would then be called net domestic product (NDP). Hence, NDP contains only the investment goods that do not simply restore the used-up capital but increase it. Although NDP seems to be a much better indicator of material welfare than the GDP, the latter is more widely used because economists do not trust depreciation statistics. Anybody familiar with bookkeeping knows how arbitrary write-off rules can be; they do not have to reflect actual depreciation of capital. For that reason many economists prefer using gross indicators because they are not affected by the write-off regulations that are not always reliable.

Public opinion demands a quantitative indicator of economic activity, and GDP has been widely accepted in this role. Consequently, many environmentalists have continued efforts to green it. Ideas emerged to exclude from GDP so-called protective goods, which do not really improve welfare but rather protect against its loss from environmental disruption. For instance, actions to prevent or remediate oil spills would be excluded from GDP. However, this is not a satisfactory solution because classifying products into distinct categories of those that improve social welfare and those that prevent welfare loss must be arbitrary. There would be a category of ambiguous products (e.g., computers) that could both improve the welfare and protect against its loss. That is why any correction rules based on common wisdom should be looked at with caution (Das-gupta and Maler 2001).

Only in the last two decades of the twentieth century did economists develop a consistent idea of how to amend the GDP (and NDP) concept in order to take the environment into account systematically. The idea is to estimate a hypothetical Bentham welfare function Wwith a linear approximation. The original Wfunction could be nonlinear in the consumption of both private and public goods, rendering it difficult to operationalize even if its formula were known. This formula is actually not known, which makes the situation even worse. Nevertheless, subject to some mathematical assumptions (that will not be discussed here), this unknown function can be approximated by a linear one constructed as the sum of products of quantities and equilibrium prices (Aronsson 2000):

Domestic product = prf^. . .+pnqn, where p1, . . . , pn stand for the prices of the n goods and services produced in the economy, and , . . . , qn denotes their quantities.

Thus an appropriately defined NDP can be interpreted as a linear approximation of an unknown welfare function. The problem then boils down to what products to include and what prices to apply. One can further demonstrate that in the case of many goods pure market prices (net of subsidies and taxes) are sufficient. Only with respect to nonmarket goods, including environmental protection, do alternative valuations need to be sought.

Thus an adequately greened NDP has a similar form to its traditional prototype except that certain goods are systematically excluded from summation (if they do not contribute to welfare), certain goods are systematically added (if they do contribute to welfare but they are neither sold nor bought on the market), and prices are not always market ones. The starting point is a greened GDP that is the sum of consumption, savings, and the environmental services that are consumed directly (not bought on the market). The greened NDP is then calculated by switching from gross to net values (i.e., instead of all savings, one has to take into account only those that increased the value of capital), and from the value of environmental services one has to subtract environmental damages (i.e., the cost incurred in order to compensate for environmental amenities lost).

Particular attention should be given to the value of capital and net savings. In modern economic theory, capital consists of three major components: human-made, natural, and human. All three can depreciate, and all three can be enhanced through investment. The depreciation of natural capital results from activities such as raw material extraction, biodiversity loss, and environmental disruption. The greened NDP thus ignores revenues from selling capital (including natural resources). According to modern economic theory, not every revenue considered an "income" in common language is a true income (Aronsson 2000:585). At least since John Hicks's (1939) fundamental work, economic income has been understood as a flow of revenues that can be sustained in the future. In other words, cash from selling a house is not income because this is a one-time transaction, and the owner simply changes the form of his or her wealth. In contrast, renting out a house may generate income.

In the environmental protection context, income is what comes from a sustainable use of resources. If the use of resources is an extractive one, it diminishes the natural capital whose depreciation should be accounted for. The greened NDP concept captures the essence of Hicksian income and hence it also brings the notion of sustainability.

To sum up, the NDP greened in the way outlined here differs from the traditional one in three aspects. First, it accounts for direct consumption of environmental services. Second, it adds investment in natural resources or subtracts their depreciation. Third, it subtracts environmental damages. The revised indicator reflects changes in social welfare better than GDP, but still this is just an approximation of the true value.

There have been numerous practical attempts to calculate a greened GDP. One of the best-known exercises is the Index of Sustainable Economic Welfare (ISEW), defined and computed for the United States by Daly and Cobb (1989). The bottom line of that study was that—contrary to conventional GDP statistics—American sustainable economic welfare has stabilized at the level of the 1970s, and it does not grow. If a greened NDP decreases, or if it increases at a rate lower than the corresponding conventional one does, it means that the economy develops in an unsustainable way. In other words, the present generation tries to meet its needs by compromising the ability of future generations to meet their own needs. Referring to our previous example, if one sells the house (which presumably could have served two or three more generations), one increases his or her economic welfare at the expense of the welfare of children. Daly and Cobb calculations suggest that this is what has happened in the United States.

Similar computations were carried out for Poland in the 1990s (Gil and Sleszynski 2003). As expected, the pace of growth measured with ISEW was lower than that measured with GDP. However, the Polish study demonstrates both theoretical and practical weaknesses of the ISEW method. The latter are caused by the lack of data necessary to calculate costs of environmental degradation and benefits from its recovery. In the absence of other data, the method allows approximation of these values with costs of environmental protection. This is highly questionable because changes in these costs do not necessarily reflect changes in environmental damages. In fact, such an assumption can be defended only where environmental policies are set at a socially optimum level. A more fundamental problem with the ISEW method is that raw GDP data (adjusted as in the greening process described earlier) are then multiplied by the income concentration index. The less egalitarian income distribution, the lower the ISEW. This reflects the assumption made in the general theory of Bergson—Samuelson social welfare function W; the theory envisages that not only the sum but also the distribution of individual wealth may affect W. Nevertheless, applying this specific measure of income concentration to ISEW is arbitrary, and it reflects a certain social philosophy adhered to by its authors. In particular, it often reflects an assumption that individual utility functions are concave. Although this general approach can be defended, specific forms of these functions are arbitrary.

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